Wednesday, April 23, 2014

The California Court of Appeal, Second District, recently held that a guarantor of a commercial loan was not liable, where the lease met California's non-termination requirements, and the borrower had not "terminated" the lease in a manner that would trigger the guaranty obligations.

Plaintiff lender ("Lender") filed suit against the guarantor ("Guarantor") of a loan used to purchase commercial property. The borrower's commercial tenant, a financial institution, went out of business, abandoned the property, and the tenant and its successor-in-interest ceased paying rent to the borrower. The borrower later stopped making its loan payments to Plaintiff Lender and defaulted on the loan. Plaintiff Lender obtained title to the property pursuant to a non-judicial foreclosure sale, and filed suit against the loan Guarantor for the balance due on the loan. Both parties filed cross-motions for summary judgment addressing the recourse provision in the loan agreement.

The trial court concluded that the tenant had terminated the lease without the Plaintiff Lender's consent and that the Guarantor was thus liable on the guaranty, pursuant to the recourse provision in the loan agreement. The court awarded the Lender over $42 million in damages plus attorney fees and costs. The Guarantor appealed the judgment and award of attorney fees.

The Court of Appeal reversed and remanded with instructions to grant summary judgment in favor of the Guarantor, ruling that the lease had not been "terminated" in a manner that triggered the recourse and guaranty provisions.

As you may recall, the California Civil Code provides that, except as otherwise provided in Section 1951.4, a lease terminates when a lessee of real property breaches the lease and abandons the property before the end of the lease term. Cal. Civ. Code § 1951.2, subdivision (a). Section 1951.4, subdivision (b), in turn provides that even where a lessee has breached a lease and abandoned the property, the lease continues in effect until such time as the lessor terminates the lessee's right of possession. Cal. Civ. Code § 1951.2, subdivision (b).

The loan guaranty agreement here provided that the guaranty would kick in upon the occurrence of certain events, including the termination or cancellation of the lease without the prior written consent of the Plaintiff Lender. Further, the lease provided that "[n]o act by Lessor [the borrower] other than giving notice of termination to Lessee shall terminate Lessee's right to possession."

The Court of Appeal determined initially that the tenant had breached the lease by stopping its rental payments and abandoning the property. In so ruling, the Court relied on the explicit terms of the lease defining "default" as including abandonment of the leased premises and failure to pay rent. The Plaintiff Lender argued that this breach constituted a "termination" of the lease that triggered the guaranty provision in the loan agreement, and cited section 1951.2, subdivision (a) as support for this argument.

The appellate court was not persuaded by Plaintiff Lender's argument, and ruled that section 1951.2 subdivision (a) did not apply to the loan guaranty in this case. Noting that the lease specifically provided that the parties' intent was that the lease would not be terminable for any reason by the lessee and that any "law to the contrary" would not change the agreement, the Court ruled that under the plain language of the lease, neither failure to pay rent nor abandonment of the property could terminate the lease.

Moreover, the Court pointed out that the Plaintiff Lender had failed to cite the critical provisions of sections 1951.2, subdivision (a) and 1951.4, subdivision (b) limiting termination of a lease to specific instances not present in this case.

The appellate court ruled that the non-termination provision of section 1951.4 applied in this case, where the borrower had not given the tenant notice of termination of tenant's right to possession pursuant to the lease's termination provision. Accordingly, the Court ruled that the lease did not "terminate" in a manner that would trigger the guaranty obligations, and the Plaintiff Lender's recourse was the security under the deed of trust, which it had already obtained in the non-judicial foreclosure sale.

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